Deck 6: Analyzing Operating Activities

Question 1

Many companies have significant deferred taxes. Deferred taxes are not always long-term liabilities. For the categories below, state whether deferred taxes can arise in this category and provide an example.i. Current liabilities
ii. Long-term liabilities
iii. Stockholders' equity
iv. Current assets
v. Long-term assets

Answer 1

Deferred taxes

Question 2

As a general rule, revenue is normally recognized when it is:

A)measurable and earned.
B)measurable and received.
C)realizable and earned.
D)realizable and measurable.

Answer 2

C

Question 3

Brierton Company enters a contract at the beginning of year 1 to build a new federal courthouse for a price of $16 million. Brierton estimates that total cost of the project will be $12 million and will take four years to complete.
Differences in taxable income and pretax accounting income that will not be offset by corresponding differences or "turn around" in future periods are called:

A)timing differences.
B)circular differences.
C)permanent differences.
D)reverse differences.

Answer 3

C

Question 4

The following information was obtained from Cyber Corporation's annual report. $\text { Common stock: shares outstanding }$
$\begin{array}{ll}\text { Balance on January } 1 & 500,000 \\\text { April } 1 \text { - issued in conversion of preferred stock } & 200,000 \\\text { July } 1 \text { - sold for cash } & \underline{ 100,000} \\ \text { Balance on December 31 } & \underline{800,000} \\\end{array}$

$\text { Preferred stock: shares outstanding }$
$\begin{array}{l}\$ 10 \text { par } 8 \% \text {, each convertible into two common shares }\\\begin{array}{lr}\text { Shares outstanding, January } 1 & 175,000 \\\text { Converted on April } 1 \text { (into 200,000 common) } & \underline{100,000} \\ \text { Shares outstanding at year-end } & \underline{ 75,000} \\\end{array}\end{array}$

Options
100,000 options each to purchase one common share at $\$ 80$ per share. None have been exercised.

$\text { Additional information: }$
$\begin{array}{lll}\text { Market prices of common stock for Year } & \begin{array}{l}\text { Average for Year } \\\$ 84\end{array} & \begin{array}{l}\text { End of Year } \\\$ 86\end{array} \\\text { Preferred dividends paid in year } & \$ 80,000 & \\\text { Net income } & \$ 1,200,000 &\end{array}$

a. Compute weighted-average number of common shares outstanding for the year.
b. Compute basic EPS.
c. Compute diluted EPS.

Question 5

Brierton Company enters a contract at the beginning of year 1 to build a new federal courthouse for a price of $16 million. Brierton estimates that total cost of the project will be $12 million and will take four years to complete. $\begin{array}{lll}&\text { Costs incurred }&\text { Payments from federal}\\&&\text { government}\\\text { Year 1 } & \$ 4 \text { million } & \$ 2 \text { million } \\\text { Year 2 } & \$ 4 \text { million } & \$ 2 \text { million } \\\text { Year 3 } & \$ 2 \text { million } & \$ 6 \text { million } \\\text { Year 4 } & \$ 2 \text { million } & \$ 6 \text { million }\end{array}$

-If Brierton used cash accounting to account for this project, what would they have reported as profit (loss) in year 2?

A)$0
B)$1.33 million
C)$(2 million)
D)$(4 million)

Question 6

Housing Construction Company (HCC) has agreed to build a housing project for the city of New York. On January 1, 2006 the company and the city agreed on the following terms, the construction should take no more than 3 years, HCC would be paid a total of $150 million for the project; $150 million would be paid: 3 payments of $50 million each at the end of year 2006, 2007, and 2008. HCC expects contractions costs to be $50 million in year 2006, $50 million in year 2007, and $10 million in year 2008.

a. If HCC uses the completed contract method, what revenues and expenses would HCC recognize in year 2006, 2007, and 2008?
b. If HCC uses the percentage-of-completion method, what revenues and expenses would HCC recognize in year 2006, 2007, and 2008?
c. Show the balance on the construction-in-process account at the end of 2006, 2007, and 2008 (prior to the completion of the project) using both the completed contract and the percentage-of-completion methods?

Question 7

For each of these nonrecurring items give an example and indicate (match with) the appropriate accounting treatment.1. Extraordinary item
2. Prior period adjustment
3. Change in accounting estimate
4. Change in accounting principle
5. Discontinued operation
6. Special items
7. Comprehensive income items
8. Change in reporting entity
9. SEC Enforcement Releases
A. Shown net as a separate line item between net income and comprehensive income, no restatement.
B. Income statement line items adjusted as appropriate, gross or net, prior years restated.
C. Gross amount is part of its regular income or expense line item in income from continuing operations, prior years restated.
D. Gross amount is part of its regular income or expense line item in income from continuing operations, no restatement.
E. Shown gross as a separate line item in income from continuing operations, no restatement.F. Shown net as a separate line item between income from continuing operations and net income, prior years restated.G. Shown cumulative net as a separate line item between income from continuing operations and net income, no restatement.H. Shown net as a separate line item between income from continuing operations and net income, no restatement.I. Not in income statement, opening retained earnings is changed by net amount, no restatement.
Chapter 06 Analyzing Operating Activities Key

Question 8

Brierton Company enters a contract at the beginning of year 1 to build a new federal courthouse for a price of $16 million. Brierton estimates that total cost of the project will be $12 million and will take four years to complete.
Which of the following statements concerning deferred taxes is correct?

A)Deferred taxes will not be found in the asset section of a balance sheet.
B)Deferred taxes arise from permanent differences in GAAP and tax accounting.
C)Deferred taxes will only decrease when a cash payment is made.
D)Deferred taxes arising from the depreciation of a specific asset will ultimately reduce to zero as the item is depreciated.

Question 9

According to FASB, initial franchise fees should be recognized as income when:

A)the franchiser has substantially performed or satisfied all material services and conditions.
B)the franchiser has collected the majority of fee in cash.
C)the franchisee shows the ability to pay the fee.
D)the franchiser bills the franchisee.

Question 10

Metals Corp. has four factories with the following data:
$\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$$\text {Book Value}$ $\quad$$\quad$$\text {Expected Cash Flows}$
$\begin{array}{lrrrrr}&\text { December 31.2006 }& \underline{2007} & \underline{2008} & \underline{2009} & \underline{2010}\\ \text { Lead factory } & \$ 100 & \$ 40 & \$ 40 & \$ 40 & \$ 40 \\\text { Copper factory } & 200 & 50 & 50 & 50 & 50 \\\text { Aluminum factory } & 300 & 80 & 80 & 80 & 80 \\\text { Zinc factory } & 400 & 60 & 60 & 60 & 60\end{array}$

All cash flows are at year-end and terminate after December 31, 2010. The company's cost of capital is 10% and its tax rate is 35%.

a. What is the value of each factory for balance sheet purposes at December 31, 2006?
b. What impairment loss, if any, would be reported on Metals' 2006 income statement? How would it be reported and where would it be reported (i.e. what component of the income statement and other disclosures)?

Question 11

Which of the following combinations of accounting practices will lead to the highest reported earnings in an inflationary environment? $\text { Depreciation Method} \quad\quad \text {Inventory Method }$
A. $\text { Straight-line } \quad \quad\quad\quad\quad\quad\text { LIFO }$
B. $\text { Double-declining balance } \quad \text { LIFO }$
C. $\text { Straight-line} \quad\quad\quad\quad\quad\quad\quad\text { FIFO}$
D. $\text { Double-declining balance } \quad \text { FIFO }$

A)Option A
B)Option B
C)Option C
D)Option D

Question 12

Below are selected portions from Quaker Oats' tax footnote in its X6 annual report.

Provisions for income taxes on income before cumulative effect of accounting change were as follows:
$\begin{array}{lrrr}\text { Dollars in Millions }&\text { X6 }&\text { X5 }&\text { X4 }\\\text { Currently payable}\\\text { Federal } & \$ 99.4 & \$ 339.1 & \$ 129.8 \\\text { Foreign } & 10.2 & 131.7 & 15.0 \\\text { State } & 26.6 & 54.9 & 40.2 \\\text { Total currently payable } & 136.2 & 525.7 & 185.0 \\\text { Deferred-net } & & & \\\text { Federal } & 15.9 & (19.8) & (42.2) \\\text { Foreign } & 10.4 & (7.3) & (3.1) \\\text { State } & 5.2 & (2.1) & (12.4) \\\text { Total deferred-net } & 31.5 & (29.2) & (57.7) \\\text { Provision for income } & \$ 167.7 & \$ 496.5 & \$ 127.3\\\text { taxes }\end{array}$

The sources of pretax income before cumulative effect of accounting change were as follows:

$\begin{array}{lrrrr}\text { Dollars in Millions } &{\text { X6 }} & \text { X5 } & \text { X4 } \\\text { U.S. sources } & \$ 362.8 & \$ 925.4 & \$ 302.2 \\\text { Foreign sources } & 52.8 & 295.1 & 18.2 \\\hline\\\text {Income before income}\\\text { taxes and }\\\text {cumulative effect of }\\\text {accounting }\\\text {change}&\$415.6&\$1,220.5&\$320.4\end{array}$ The components of the deferred income tax provision (benefit) were as follows:

$\begin{array}{lcccc}\text { Dollars in Millions } & {\text { X6 }} & \text { X5 } & \text { X4 } \\\text { Accelerated tax depreciation } & \$ 3.7 & \$(23.8) & \$ 8.8 \\\text { Postretirement benefits } & 0.6 & (6.5) & (6.0)\\\text { Accrued expenses including }\\ \text { restructuring charges } & 40.6 & 12.6 & (30.8) \\\text { Loss carryforwards } & (7.1) & 3.5 & (6.1) \\\text { Foreign gain deferral } & 9.8 & - & - \\\text { Other } & (16.1) & (15.0) & (23.6)\\\text {Provision (benefit) for deferred}\\ \text {income taxes}&\$31.5&\$(29.2)&\$(57.7)\\\end{array}$

Deferred tax assets and deferred tax liabilities were as follows:
$\begin{array}{lrcrc}\text { Dollars in Millions } &\quad\quad\quad {\text { X6 }} &\quad\quad\quad\quad\quad {\text { X5 }} \\& \text { Assets } & \text { Liabilities } & \text { Assets } & \text { Liabilities } \\\text { Depreciation and amortization } & \$ 56.9 & \$ 400.1 & \$ 58.8 & \$ 405.6 \\\text { Postretirement benefits } & 100.3 & - & 100.9 & -\\\text { Other benefit plans } & 60.8 & 9.2 & 59.8 & 20.2 \\\text { Accrued expenses including }\\\quad \text { restructuring charges } & 80.3 & 7.9 & 147.9 & 10.4 \\ \text { Loss carryforwards }& 14.5 & - & 13.5 & - \\\text { Other } & 13.3 & 33.2 & 15.9 & 22.8 \\\text { Subtotal } & 326.1 & 450.4 & 396.8 & 459.0 \\\text { Valuation allowance } & (14.2) & - & (20.0) & - \\\text {Total}& \$ 311.9 & \$ 450.4 & \$ 376.8 & \$ 459.0\end{array}$
Required:

1a. What was the effective tax rate on all income for fiscal X6?
1b. What was the effective tax rate on foreign income for fiscal X6?

2a. How much did Quaker Oats record in deferred taxes for fiscal X6? Was this an asset or liability?
2b. What was the major item contributing to the deferred tax for X6? Explain fully how this arose.

Question 13

Which of the following measures of accounting income is typically reported in an income statement?

A)Net income
B)Comprehensive income
C)Continuing income
D)All of the above

Question 14

You are reading the 2006 annual report of Curpen Corporation and you find the following items in its footnotes.a. The useful life of machinery has been increased from 10 to 15 years.b. The expected rate of return on plan assets has been increased to 10% from 8%.c. The company has started to capitalize small tools purchased beginning in 2006.For each of the above, determine the effect (higher, lower, or unchanged) of the change on the ratios listed below for the year 2006:
a. Debt-to-equity
b. Return on assets
c. Cash Flow from operations

Question 15

Which of the following is not a reason for economic income and accounting income to differ?

A)Transaction basis
B)The monetary assumption
C)Conservatism
D)Earnings management

Question 16

Companies can capitalize software development costs when the product is "technologically feasible". Some companies never capitalize their software costs - for example, Microsoft.Viderics, a software development company capitalizes those software costs allowed under GAAP. The following information is taken from its financial statements.a. If Viderics had not capitalized its software costs but expensed them instead what would they have reported as software expense each year, assuming unamortized balance of software costs was $35 in year X0?
b. What is the likely effect upon net income variability of expensing rather than capitalizing software development costs?
c. How might income be manipulated under either of these two methods (expensing and capitalizing)?

Question 17

XYZ Company issued 10,000 options to its CEO on January 1, 2006, at the prevailing market price of $5 per share. The options were expected to vest over a 2-year period. The Black-Scholes value of the option was valued at $2 per share. On December 31, 2007, the CEO exercised all options. Market price on that day was $9 per share. Assume a 35% tax rate.

1. What will be the cumulative effect on the balance sheet as of December 31, 2007 before the exercise of option?
2. What will be the cumulative effect on the balance sheet as of December 31, 2007 after the exercise of option?

Question 18

Brierton Company enters a contract at the beginning of year 1 to build a new federal courthouse for a price of $16 million. Brierton estimates that total cost of the project will be $12 million and will take four years to complete. $\begin{array}{lll}&\text { Costs incurred }&\text { Payments from federal}\\&&\text { government}\\\text { Year 1 } & \$ 4 \text { million } & \$ 2 \text { million } \\\text { Year 2 } & \$ 4 \text { million } & \$ 2 \text { million } \\\text { Year 3 } & \$ 2 \text { million } & \$ 6 \text { million } \\\text { Year 4 } & \$ 2 \text { million } & \$ 6 \text { million }\end{array}$

-If Brierton used percentage-of-completion method to account for this project, what would they have reported as profit in year 2?

A)$0
B)$1.33 million
C)$1.50 million
D)$0.67 million

Question 19

Brierton Company enters a contract at the beginning of year 1 to build a new federal courthouse for a price of $16 million. Brierton estimates that total cost of the project will be $12 million and will take four years to complete.
Which of the following is correct? I. If a company uses straight-line depreciation for financial reporting purposes, it is very likely they have a deferred tax liability with respect to its depreciable assets.II. Straight-line depreciation yields an increasing rate of return on book value over the life of an asset.III. Straight-line depreciation results in lower tax payments than accelerated depreciation methods over the life of an asset.IV. If a company revises its estimate of the useful life of an asset upwards this will decrease annual depreciation expense.

A)I, II, III, and IV
B)I, II, and IV
C)I, II, and III
D)I and IV

Question 20

The table below shows the differences in accounting treatments for goodwill in three selected countries.
$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\text { Accounting for goodwill in selected countries }$
$\begin{array}{lccc} &\text { Option to expense }&\text {Option to charge to }\\&\underline{ \text { immediately }} &\underline{ \text { equity }} & \underline{\text { Tax deductible }} \\\text { United States }& \text { No } & \text { No } & \text { No* } \\\text { Great Britain } & \text { No } & \text { No } & \text { Yes } \\\text { No } & \text { Yes } & \text { No } & \text { No }\end{array}$
*Goodwill is tax deductible in the United States under limited circumstances, for the purposes of this question, assume it is not.

Given a company that has recognized significant acquisition goodwill, identify the country whose accounting and tax rules for goodwill would likely result in the highest valuation of the company. Justify and explain your answer.

Question 21

Tecktroniks Company reported in its annual report software refinement expenses of $12 million, $15 million, and $18 million for fiscal years 2005, 2006, and 2007, respectively. At the end of fiscal 2007, it had total assets of $140 million. Net income was $20 million for fiscal 2007, and it had a marginal tax rate of 35%.
If software refinement had been capitalized each year and amortized over a three-year period beginning in the year the cost was incurred, total assets at the end of fiscal 2007 would have been:

A)$185 million.
B)$172 million.
C)$158 million.
D)$157 million.

Question 22

Which of the following statements is correct? I. Tax loss carrybacks result in deferred tax assets.II. Tax loss carryforwards result in deferred tax assets.III. The tax valuation account is used to adjust deferred tax liabilities if it is "more likely than not" that they will not result in increased future taxes.

A)I only
B)II only
C)III only
D)I and II

Question 23

If a company estimates that its expected return on pension plan assets will increase to 9.5% from 9.0%, this would be considered:

A)an extraordinary gain.
B)a change in accounting principle.
C)a prior period adjustment.
D)a change in accounting estimate.

Question 24

Tecktroniks Company reported in its annual report software refinement expenses of $12 million, $15 million, and $18 million for fiscal years 2005, 2006, and 2007, respectively. At the end of fiscal 2007, it had total assets of $140 million. Net income was $20 million for fiscal 2007, and it had a marginal tax rate of 35%.
If the software refinement had been capitalized and amortized over a three-year period beginning in the year the cost was incurred, but was expensed for tax purposes, the deferred tax position at the end of fiscal 2005 would have been:

A)a deferred tax credit of $2.8 million.
B)a deferred tax credit of $3.5 million.
C)a deferred tax credit of $5.2 million.
D)a deferred tax debit of $4 million.

Question 25

Which of the following will cause the reported effective tax rate to differ from the federal statutory tax rate? I. Foreign tax rates that are lower than federal statutory tax rate
II) Tax-exempt income
III) Different depreciation methods for tax and financial reporting purposes
IV) Foreign tax rates that are higher than federal statutory tax rate

A)I, II, and IV
B)I, II, and III
C)I and II
D)III only

Question 26

The capitalization of interest cost during construction:

A)increases future net income.
B)decreases future depreciation expense.
C)increases net income during construction phase.
D)decreases assets during construction phase.

Question 27

Tecktroniks Company reported in its annual report software refinement expenses of $12 million, $15 million, and $18 million for fiscal years 2005, 2006, and 2007, respectively. At the end of fiscal 2007, it had total assets of $140 million. Net income was $20 million for fiscal 2007, and it had a marginal tax rate of 35%.
If software refinement had been capitalized each year and amortized over a three-year period beginning in the year the cost was incurred, net income for fiscal 2007 would have been:

A)$31.7 million.
B)$29.75 million.
C)$21.95 million.
D)$14.95 million.

Question 28

Which of the following is true with respect to extraordinary items? I. Extraordinary items are recorded net of tax in income statement.II. Extraordinary items, by definition, are probable and unusual in nature.III. By definition, gains and losses from strikes are always extraordinary.IV. By definition, gains and losses from sale of property, plant and equipment are never extraordinary.

A)I and IV
B)I, III, and IV
C)II and IV
D)I, II, and III

Question 29

The following information was extracted from Smurm Corporation's 2006 annual report:
$\begin{array}{lr}\text { Common stock }\\\text { Shares outstanding } 12 / 31 / 05 & 90 \text { million } \\\text { New shares issued } 4 / 1 / 06 & 10 \text { million } \\\text { Shares outstanding } 12 / 31 / 06 & 100 \text { million }\end{array}$

$\text { Preferred stock }$
$\$ 10$ par, $10 \%$ , convertible into 2 shares of common stock, shares outstanding $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$50 \text { million }$
1 million options, each to purchase one common share at $\$ 50$ per share

$\begin{array}{lr} \text { Average for year} &\$75\\ \text { Beginning of year } &\$70\\ \text {End of year } &\$78\\\\ \text { Preferred dividends paid}&\$50,000,000\\ \text { Net income for 2006}&\$350,000,000\end{array}$

-Basic earnings per share for 2006 was:

A)$3.50.
B)$3.16.
C)$3.08.
D)$3.00.

Question 30

Exoil recorded an expense and corresponding liability to recognize potential losses relating to an oil spill in 2006 of $10 million. Its net income for the year was $200 million. It was not able to take a deduction for tax purposes until later years when it actually paid cash out in relation to this event. In 2006, with respect to this, Exoil would have:

A)recognized a deferred tax liability.
B)recognized a tax loss carryforward.
C)recognized a deferred tax asset.
D)recognized a deferred equity loss.

Question 31

Assume a company that normally expenses advertising costs was to capitalize and amortize these costs over 3 years instead. After the third year net income would:

A)be higher, irrespective of the change in advertising costs.
B)be lower, irrespective of the change in advertising costs.
C)be higher only if advertising costs were increasing.
D)be lower only if advertising costs were increasing.

Question 32

The following information was extracted from Smurm Corporation's 2006 annual report:
$\begin{array}{lr}\text { Common stock }\\\text { Shares outstanding } 12 / 31 / 05 & 90 \text { million } \\\text { New shares issued } 4 / 1 / 06 & 10 \text { million } \\\text { Shares outstanding } 12 / 31 / 06 & 100 \text { million }\end{array}$

$\text { Preferred stock }$
$\$ 10$ par, $10 \%$ , convertible into 2 shares of common stock, shares outstanding $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$50 \text { million }$
1 million options, each to purchase one common share at $\$ 50$ per share

$\begin{array}{lr} \text { Average for year} &\$75\\ \text { Beginning of year } &\$70\\ \text {End of year } &\$78\\\\ \text { Preferred dividends paid}&\$50,000,000\\ \text { Net income for 2006}&\$350,000,000\end{array}$

-Diluted earnings per share for 2006 was:

A)$3.52.
B)$3.07.
C)$2.00.
D)$2.03.

Question 33

Windsor Company has net temporary differences between tax and book accounting of $80 million, resulting in a deferred tax liability of $28 million. An increase in the tax rate would have the following impact on deferred taxes and net income: $$\begin{array} { l c c } & \text { Deferred Taxes } & \text { Net Income } \\\text { A) } & \text { Increase } & \text { No effect } \\\text { B) } & \text { Increase } & \text { Decrease } \\\text { C) } & \text { No effect } & \text { No effect } \\\text { D) } & \text { Decrease } & \text { No effect }\end{array}$$

A)Option A
B)Option B
C)Option C
D)Option D

Question 34

If a company changes the useful life of its assets from 10 years to 12 years, this will be recorded as:

A)a nonrecurring gain.
B)an extraordinary item.
C)a change in accounting principle.
D)None of the above

Question 35

Which of the following items is not included in the calculation of net income but is included in the calculation of comprehensive income?

A)Unrealized holding gain on available-for-sale marketable securities
B)Unrealized holding gain on trading marketable securities
C)Gain from early extinguishments of bonds
D)Gain arising from sale of available-for-sale marketable securities

Question 36

A company changes its depreciation method from an accelerated system to straight-line. Which of the following would normally be true? I. The change would be discussed in the auditor's report.II. The cumulative effect of the change would appear, net of tax, on the income statement.III. The change would appear in cash flow from operations as a cash inflow.IV. The change would be mentioned in the footnotes.

A)I, II, III, and IV
B)I, II, and III
C)II and IV
D)I, II, and IV

Question 37

Compared with companies that expense costs, firms that capitalize costs can be expected to report:

A)higher asset levels and lower equity levels.
B)higher asset levels and higher equity levels.
C)lower asset levels and higher equity levels.
D)lower asset levels and lower equity levels.

Question 38

Two growing firms are identical except that one firm capitalizes, whereas the other firm expenses costs for long-lived resources over time. For these two firms, which of the following statements is generally true? I. The expensing firm will show a more volatile pattern of reported income than capitalizing firm.II. The expensing firm will show a less volatile pattern of return on assets than the capitalizing firm.III. The expensing firm will show lower cash flows from operations than the capitalizing firm.

A)I only
B)II only
C)I and III only
D)II and III only

Question 39

Which of the following would be considered an extraordinary item? I. Write-down of receivables
II) Gains on disposal of a business segment
III) Loss of inventory resulting from a fire
IV) Loss resulting from a strike

A)I and IV
B)I, III, and IV
C)III only
D)I, II, and III

Question 40

The following information was extracted from Smurm Corporation's 2006 annual report:
$\begin{array}{lr}\text { Common stock }\\\text { Shares outstanding } 12 / 31 / 05 & 90 \text { million } \\\text { New shares issued } 4 / 1 / 06 & 10 \text { million } \\\text { Shares outstanding } 12 / 31 / 06 & 100 \text { million }\end{array}$

$\text { Preferred stock }$
$\$ 10$ par, $10 \%$ , convertible into 2 shares of common stock, shares outstanding $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$50 \text { million }$
1 million options, each to purchase one common share at $\$ 50$ per share

$\begin{array}{lr} \text { Average for year} &\$75\\ \text { Beginning of year } &\$70\\ \text {End of year } &\$78\\\\ \text { Preferred dividends paid}&\$50,000,000\\ \text { Net income for 2006}&\$350,000,000\end{array}$

-Using the treasury stock method, calculate the number of extra shares being recognized in the diluted EPS calculation resulting from options.

A)500,000
B)358,975
C)333,333
D)285,714

Question 41

Income from continuing operations is a measure that excludes certain nonrecurring items, such as extraordinary items, and the effects of discontinued operations, from net income.

Question 42

Generally revenue should be recorded when it is probable and reasonably estimable.

Question 43

Which of the following statements is incorrect?

A)Employee stock options are not recorded as an expense when granted if they are out-of-the money under the intrinsic value method.
B)Employee stock options will not affect the share price of a company when exercised.
C)Employee stock options may reduce agency costs by more closely aligning interests of stockholders and managers.
D)Employee stock options may increase the risk propensity of managers.

Question 44

For item to be considered extraordinary, it should be either unusual in nature or infrequent in occurrence.

Question 45

Which of the following is not an extraordinary item? I. Loss on abandonment of property
II) Gain on disposal of a business segment
III) Effect of a strike against a key supplier
IV) Write-down of deferred research and development costs

A)I and III
B)II and IV
C)I, II, and III
D)I, II, III, and IV

Question 46

The intrinsic value approach ignores two types of costs:

A)interest cost and opportunity cost.
B)opportunity cost and exercise cost.
C)interest cost and option cost.
D)carrying cost and interest cost.

Question 47

Revenue from sales where the buyer has the right of return can only be recognized after the return period has expired.

Question 48

Accounting changes are usually cosmetic and do not yield cash flow consequences.

Question 49

A long-term asset is said to be impaired when its fair value is below its book value.

Question 50

All other things being equal, when comparing expensing or capitalizing the R&D expenditures (with straight-line depreciation), return on assets:

A)will decrease over time using capitalization.
B)will increase over time using capitalization.
C)will be constant using expensing.
D)will initially be higher under expensing.

Question 51

Smythe Corporation is in the real estate development business. If they sell a piece of land for $50,000 that they had previously purchased for $45,000, they should record a loss of $5,000.

Question 52

The matching principle in accounting prescribes that costs must be recognized in the same period when the related revenues are recognized.

Question 53

Revenues are earned inflows that arise from a company's ongoing business activities.

Question 54

Based on GAAP, which of the following is true of comprehensive income?

A)It should be reported as part of sales in the income statement.
B)It can be reported as part of statement of shareholders' equity.
C)It should be reported as a line item before earnings after tax in the balance sheet.
D)It should be reported as part of operating activities in the statement of cash flows.

Question 55

Which of the following overall accounting concepts has a number of exceptions under GAAP?

A)Historical cost
B)Transaction basis
C)Conservatism
D)Accrual accounting

Question 56

Economic income and accounting income are always the same.

Question 57

Gains are earned inflows that arise from a company's ongoing business activities.

Question 58

For item to be considered a special item, it should be either unusual in nature or infrequent in occurrence but not both.

Question 59

Comprehensive income is computed by adjusting net income, on an after-tax basis, for certain unrealized gains and losses.

Question 60

If two firms are identical except that one firm uses percentage-of-completion accounting and the other uses completed contract accounting for revenue recognition, the cash flows of the firms will be identical.

Question 61

Timing is one of the few revenue recognition issues that are seldom a concern in financial analysis.

Question 62

Comprehensive income reflects nearly all changes to equity, other than those from owner activities (such as dividends and share issuances)

Question 63

The capitalization of interest costs during construction increases future net income.

Question 64

If revenue is recognized for financial reporting purposes but deferred for tax purposes this results in a deferred tax liability.

Question 65

If an expense is recognized for financial reporting purposes but not allowed as a bona-fide deduction for tax purposes, this results in a deferred tax asset.

Question 66

Extraordinary items are defined as those that are both unusual in nature and infrequent in occurrence. These items are disclosed, net of tax in the income statement.

Question 67

Deferred taxes arise due to temporary timing differences in recognizing items for tax and financial reporting purposes.

Question 68

Accounting errors are considered accounting changes and treated accordingly.

Question 69

In order to determine permanent income for the year being analyzed, it is necessary to consider special charges from other years.

Question 70

For companies in an expansion phase, capitalizing interest may result in higher earnings over an extended period of time, compared to expensing interest.

Question 71

Only costs of materials, equipment, and facilities having alternative future uses (in R&D projects or otherwise) are capitalized as tangible assets.

Question 72

Employee stock options (ESOs) usually constitute a wealth transfer from current shareholders to prospective shareholders (employees) and have no effect on total liabilities and shareholders' equity.

Question 73

If a company depreciates an asset at a faster rate for tax purposes than for financial reporting purposes this will give rise to a deferred tax liability.

Question 74

When a company disposes of a segment of its business, it must restate all prior year financial statements as if it had never owned that segment of the business.

Question 75

All other things equal, a company that capitalizes rather than expenses software development costs, will have a less volatile net income.

Question 76

Some items appear on a company's income statement but never appear on its tax return.

Question 77

A deferred tax liability imposes an obligation on the business to pay taxes.

Question 78

If a company, operating in an inflationary environment, uses FIFO for tax purposes and weighted-average for financial reporting purposes, this will result in a deferred tax asset.

Question 79

Software costs may be capitalized once a company can show that the product is technologically feasible.

Question 80

A company that capitalizes costs, rather than expensing them will have a higher asset turnover.